How does the availability of tax-favored retirement saving affect national saving?
It only increases private saving if the tax breaks encourage households to set aside additional cash rather than simply transferring it from other nest eggs. It only increases national saving if the increase in private saving exceeds the revenue loss from the tax subsidy.
Tax-favored retirement savings accounts are popular: half of working adults take advantage of them. It’s unclear, however, whether they make much difference to overall savings and retirement preparedness. Although traditional pensions and other tax-deferred vehicles such as 401(k) plans and individual retirement accounts (IRAs) do make up a sizable share of households’ wealth, the accounts only increase private saving if they encourage households to finance their own contributions through reductions in consumption or increases in earnings.
Put another way, incentives do not increase private saving if households finance their contributions by borrowing, by shifting their existing assets into tax-favored accounts, or by shifting current saving that would have occurred even in the absence of the incentive. Likewise, there is no increase in private saving if households respond to employer-provided pensions or contributions with equivalent reductions in other saving or with increased borrowing.
The earliest research on both traditional defined-benefit pensions and defined-contribution plans suggested that they had a very strong impact on private wealth and saving. These studies, however, were marred by technical missteps, and later research has found a significantly smaller impact—and, in some cases, none at all.
To the extent that the tax incentives do raise saving, the impact can be expected to be greater for lower- and middle-income households than for high-income households, who tend to use the accounts as a means to reduce present or future tax liability.
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Chetty, Raj, John Friedman, Soren Leth-Petersen, Torben Nielsen, and Tore Olsen. 2012. “Active vs. Passive Decisions and Crowd-Out in Retirement Savings Accounts: Evidence from Denmark.” NBER working paper 18565. Cambridge, MA: National Bureau of Economic Research.
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